Beware of Unintended Consequences to the Volcker Rule

Although President Obama's "Volcker Rule" - his proposal that banks forego proprietary trading, investment or ownership in hedge funds and private equity firms and not be allowed to become too big to fail - could take three to five years to move through Congress and become implemented, if some version of it does get passed, it could have a profound impact on banks, said Matt Cohn, partner and leade

Although President Obama's "Volcker Rule" - his proposal that banks forego proprietary trading, investment or ownership in hedge funds and private equity firms and not be allowed to become too big to fail - could take three to five years to move through Congress and become implemented, if some version of it does get passed, it could have a profound impact on banks, said Matt Cohn, partner and leader of Capco's banking group, in an interview this week.Cohn believes there is a need for regulatory reform to address the issues of too big to fail, as he describes it, "the implicit guarantee that some members of the industry get the benefit and revenue when the economy is doing well, but then when the risks are too excessive then they can put it back on the government." But the challenge is addressing the root cause, excessive risk taking and reward for institutions and individuals, without enacting rules that lead to unintended consequences.

"The big concern I have is that you're addressing some of the problems after the fact with new rules and regulations that may have a substantial set of ramifications on the health of the economy as it turns around," he says. "Washington has to strike a fine balance between regulatory reform that protects against moral hazard and also not bashing the banks to the extent that they can't support and promote the growth of the economy, housing recovery and job growth."

Definitions will be critical to complying with this set of rules, Cohn says. For instance, some banks, such as JPMorgan Chase, have a "passive" or "partial" ownership in hedge funds - will they be required to sell them off or could they simply change their legal status? "I don't think there's any clarity right now about what that means to those types of businesses," Cohn says. Lawyers will delve into these issues first.

But there will undoubtedly be a technology impact on banks if the Volcker rules get enacted, Cohn says. One effect will be increased regulatory reporting and transparency requirements, particularly around proprietary trading so that banks can demonstrate that they're in compliance, he says. "Banks will have to adjust, from an operational and a risk perspective, how they're processing transactions on a day-to-day basis, and/or how they're ultimately reporting against those and communicating that up," Cohn says.